Date: MAY 1992
Subject: Valuing stock options in a compensation Package
Purpose: To determine which option worth for Mrs Jameson, and how long should she stay at Telster.

Q1,2: The stock currently trading at $18.75. (20.25-18.75)x3000=4500. If she choose cash compensation package and if there is no TAX, She will receive $5000+(5000x3.8%). Obviously it is worth than stock option.

Q3: The options do not vest until the fifth year and the strike price is $35. What is the price of the 5-year option?
If Jameson chose stock options, she would hold European 3000 call options (early exercise is impossible) on stocks without dividends which give her the right to buy Telstar stocks at the strike price $35 per share in the 5th year from the date she joins Telstar. The option price is $2.65. Total value of 3000 call options that Jameson would receive is 3000 x $2.65 = $7943 (taxes and transaction costs are ignored), which is option premiums that Jameson can receive if she sells her 3000 granted options.

Q4: If Jameson chose cash compensation package and if there is no tax, she will receive $5000 today. If she used this money to invest in 5-year T-bills, the future value of her compensation would be worth: $5000 x 1.0602 = $5301 in 5 years. $7943 is worth than $5301.

If she accepts deal (stock option and job), she should untie her wealth from the fortunes of Telstar by using bull spread strategy, which is to sell identical call options with higher strike price, for instance $40, to insure her long call position. Buy selling option at $40 strike price, she can get option premiums. If Telstar’s stock price will not rise to $35, she will not exercise options granted by Telstar but can get option premiums to compensate her losses from not being able to exercise options. If stock price rises above $35, she will exercise options granted by Telstar and gain profits =